UNITED STATES OF AMERICA
Before the
COMMODITY FUTURES TRADING COMMISSION

MARK A. FERRIOLA
v.

CFTC Docket No. 98-R114

OPINION AND ORDER

CARLO SCOTT KEARSE-McNEILL

Respondent Carlo Scott Kearse-McNeill
("McNeill") appeals from an initial decision that ordered
him to pay $50,500 plus interest to complainant Mark A. Ferriola
("Ferriola").1 The
Administrative Law Judge ("ALJ") found him liable under
Section 4b of the Commodity Exchange Act ("Act") for both
fraudulently inducing complainant to open and maintain his options
account and trading complainant's account to generate commissions.
McNeill asserts that the ALJ should be disqualified for bias. In
addition, he challenges both the ALJ's implicit credibility
determination and factual assessments as contrary to the record.
Complainant urges the Commission to affirm the judge in all
respects.

As explained below, based upon our
independent review of the record, we conclude that McNeill violated
Section 4c(b) of the Act and Commission Rule 33.10 through fraudulent
inducement and churning. We decline to award damages at this time,
however, because the record is ambiguous on the amount of damages
already collected by Ferriola. Consequently, we grant complainant 30
days to show cause why the damage award should not be reduced to
$45,050 plus interest.
BACKGROUND

I.

Ferriola filed his complaint in March 1998. He sought damages of over
$53,000 from McNeill, Gray, and Transamerican, a registered
introducing broker ("IB").2 In essence, the complaint alleged that
McNeill and Gray had (1) fraudulently induced Ferriola to open and
maintain his account, and (2) traded the account to generate
commissions. Ferriola claimed that McNeill and Gray's conduct
violated Section 4b of the Act and that Transamerican was liable for
its employees' wrongdoing pursuant to Section 2(a)(1)(A) of the
Act. Complainant selected the voluntary decisional process and paid a
$50 filing fee.

The complaint alleged that Ferriola had
no experience in sophisticated investments when McNeill solicited him
to open an account at Transamerican. During the solicitation, McNeill
failed to discuss the risks of options trading. He did, however,
describe the success his clients were having and assure Ferriola that
he would have similar success if he opened an options account and
retained McNeill as his account executive. According to the complaint,
Ferriola specifically told McNeill that he did not understand the
market. In addition, it alleged that complainant trusted McNeill to
handle and protect his funds in a professional manner

The complaint indicated that Ferriola
opened his Transamerican account and deposited $20,000 on March 28,
1996. On the same day, complainant purchased the 20 July unleaded gas
call options that McNeill had recommended. Ferriola maintained his
account until July 1996, and made separate $20,000 deposits on April
1, April 11, and May 2. Complainant claimed that McNeill downplayed
the risk and promised that he would protect complainant's
investment. Moreover, when the value of his account fell, McNeill
offered assurances that losses would be recovered. Complainant also
claimed that both McNeill and Gray urged him to borrow money against
his credit cards to make his fourth $20,000 deposit.

The complaint alleged that each of the
trades in Ferriola's account was based on McNeill's
recommendation. It noted that McNeill traded several different
commodities and generally selected large positions that generated
substantial commissions. Ferriola acknowledged that several of
McNeill's April trades were profitable, but emphasized that these
profits were immediately reinvested in the market. He alleged that he
paid almost $7,000 in commissions and fees in March, $25,000 in April,
and $22,000 in May. By the time he closed his account in July,
Ferriola had paid commissions and fees of $55,645 and suffered a net
loss of $53,105.

McNeill and Gray filed a joint answer in
May 1998.3 Both respondents
generally denied complainant's allegations of wrongdoing. Gray
denied that he had either made trades for Ferriola's account or
advised him about how his account should be traded. McNeill alleged
that he had informed complainant that futures trading involved a high
degree of risk and could result in substantial losses, as well as
substantial gains, in a short period of time. The answer also
emphasized that Ferriola had a net worth of $1,000,000, had approved
each trade in advance, had been kept apprised of the value of his
account at all times, and had failed to stop trading when the account
was profitable.

After the case was assigned to an ALJ, he
issued an order establishing discovery procedures and a deadline for
submitting prehearing memoranda. During the discovery period,
Ferriola, Gray and McNeill exchanged discovery requests. In
September 1998, they submitted prehearing memoranda focused on the
issues raised in the complaint and answer.

II.

In February 1999, the ALJ conducted a
one-day hearing in Chicago, Illinois. Ferriola and McNeill were the
only witnesses. Gray did not attend the hearing. Transamerican did not
appear.4

Ferriola testified that he had no
experience with either securities or futures trading at the time of
his initial conversation with McNeill. He said that McNeill called him
in March 1996 when he had cash available for investing due to his
recent sale of his retail tool business. Complainant testified that
his income at that time was $60,000 and that his net worth, excluding
his primary residence, was about $175,000. According to Ferriola, when
he informed McNeill that he had $20,000 to invest, McNeill convinced
him that he could make money trading option contracts. Ferriola
claimed that McNeill advised him not to worry because "I
[McNeill] will make you tons of money." Transcript at 19.

As a result of this solicitation,
Ferriola explained, he filled out the necessary account-opening
documents and faxed them to Transamerican on March 27, 1996. He faxed
a copy of a check for $20,000 on March 28 and, later in the day, sent
the check by Federal Express. According to complainant, he faxed a
copy of the check first because McNeill "wanted to start right
away." Id. at 21. He explained further that McNeill
advised that unleaded gas options were "the best thing to get
into at the time." Id. at 22.

Ferriola testified that he submitted an
additional $20,000 on April 1 after McNeill told him "[he] could
make a lot of money." Id. at 25. Complainant said that he
submitted an additional $20,000 on April 8 after McNeill told him that
"I can double my money." Id. at 32. Ferriola
explained that his fourth $20,000 deposit came from an equity line of
credit on his house. He testified that McNeill encouraged him to
borrow these funds to increase the funds available for trading.
Id. at 36.

Ferriola emphasized that he relied on
McNeill's trading advice and described his own approach as going
"with the flow." Id. at 23, 25. He acknowledged that
he approved each trade in advance, but claimed that McNeill was
"basically making his own decisions." Id. at 26. He
explained that he trusted McNeill and believed that "if you give
a firm that much money, they should take care of you." Id.
at 32. Ferriola admitted that sometimes he would respond to
McNeill's recommendation with "something different
maybe," but explained that he ultimately accepted the advice
saying, "if that's the way you want to do it."
Id. at 26. Ferriola indicated that he knew that the commission
charge would be $160 per contract, but that he was not worried
"[b]ecause [he] was told [he] could make some money."
Id. at 22.5

During cross-examination, counsel for
McNeill and Gray questioned Ferriola about the account-opening
documents that he had reviewed and signed. Ferriola acknowledged that
he listed his net worth as $1,000,000, although this information was
"not right." Id. at 39. Ferriola also admitted that
he signed an acknowledgement of risk,6 but explained that he "was just
listening to [his] broker basically," id. at 41, and had
only "skimmed over" the document because McNeill "got
[him] psyched up or fired up or whatever." Id. at
66.

Counsel also questioned Ferriola about
his approval of the trades McNeill made. When queried about his
knowledge of the commission that would be charged for the initial
trade, complainant explained that while he literally knew what the
commission per contract would be, he "actually didn't realize
it." Id. at 46, 22. He explained that his focus was on the
profit he could earn:

"I was not thinking [when the first trade was made] as far as
the money I had involved in there. He [McNeill] said 'you have to
do it now.' 'Do it now.' 'In the next couple of days
you will make so much money.' So I did it. I was not thinking
about commissions at the time."
Id. Complainant reiterated his claim that he followed
McNeill's recommendations because he "had trust in him
basically," id., but did acknowledge that he had asked
McNeill "[a] lot of things," id. at 47, and received
undated crop reports to review. Id.

When questioned about his knowledge of the risk of loss, Ferriola
conceded that it was "possible" that he knew that he could
lose money just as quickly as he had made it. Id. at 52. He
acknowledged that he did not order his account liquidated when it
showed a profit of almost $9,000 on April 11, but noted that McNeill
"kept finding different things for me to buy." Id. at
53. He also admitted that the value of his account had fallen by
almost $16,000 by April 19, but explained that he had discussed the
losses with McNeill and been assured that he "[would] bring [me]
back." Id. He also testified that sometime between April
19 and May 3 he advised McNeill that he wanted to get out of some of
his positions, but that McNeill talked him into staying with an
assurance that "[w]e are coming back." Id. at 56,
52.

Complainant offered limited testimony about Gray's role in the
trading of his account. When questioned about the complaint's
allegation that Ferriola borrowed the final $20,000 he deposited in
his account on May 2 based on representations made by Gray, Ferriola
claimed that "[s]ome dates are messed up here." Id.
at 60. When asked whether his conversations with Gray were not later,
at the time complainant wanted to close his account, Ferriola observed
that: "I talked to him occasionally." Id. at
61.

Finally, counsel asked complainant about
the quality of his recollection of McNeill's representations about
profit expectations. Counsel noted that Ferriola modified many of his
answers with the term "basically" and suggested that
complainant was not providing a word-for-word description of
McNeill's representations. Complainant acknowledged that this was
true but insisted that "it's similar though." Id.
at 49. Counsel then focused on Ferriola's testimony that McNeill
had represented that he could double his money:

Q. Okay. So it was your understanding that you could double
your money, not that you would double your money? (emphasis
added).

McNeill testified that he advised
Ferriola that trading options on commodity futures was a "high
risk venture." Id. at 94. He explained that he followed a
balanced approach, advising complainant that "you can make money
doing this and lose money." Id. at 95. He acknowledged
offering his opinion about profit opportunities, but denied that he
guaranteed any profit, definitively stated that complainant would make
a specific number of dollars on a trade, or claimed that he would
double complainant's money. Id. He also denied encouraging
Ferriola to borrow money for options trading. Id. at 96.

McNeill also testified regarding
Gray's conversations with Ferriola, claiming that he had listened
in on every telephone conversation between Gray and complainant.
Id. at 97-98. He testified that Gray did not instruct complainant
to borrow money to trade options. Id. at 98. He also declared
that he never heard Gray offer Ferriola any trade recommendations.
Id. at 109.8

Ferriola's counsel focused his
examination on McNeill's qualifications and his rationale for
frequently trading large positions in out-of-the-money
("OTM") options.9
McNeill testified that he was a high school graduate whose formal
futures-related training consisted of taking preparatory courses for
the Series 3 examination. Id. at 81-82. He emphasized, however,
that he used sources such as the Wall Street Journal, The Financial
Times and CNBC and had been analyzing markets long enough "to be
considered an analyst." Id. at 82-83.

In response to questions about the basis
for the initial trade he recommended, McNeill stated that he
recommended a 20 contract position in unleaded gas options because he
wanted to control about 1 million gallons of unleaded gas. He believed
this level of leverage was appropriate because "in options
leverage makes money when the option moves in your favor."
Id. at 85-86. When asked about his urgency to enter this trade so
quickly, McNeill explained that "we had looked at unleaded gas,
and it was spring." Id. at 90.10 Asked his rationale for recommending
OTM options rather than in-the-money ("ITM") options,
McNeill emphasized that one could gain extra "leverage" by
purchasing OTM options - "I explained that the closer to the
money you go the more you have to pay in premium so the less contracts
you get and less leverage you get." Id. at 91.

McNeill insisted that he based every
trade recommendation solely on his assessment of the client's best
interests, including the potential effect of the commissions on the
client's account. Id. at 71. As to his overall trading
methodology, McNeill explained that he based his recommendations on
"[m]any things" such as "current events, earthquakes,
death, destruction, famine, flood, drought, Saddam Hussein,
Whitewater, Monica Lewinsky. You know, on and on and on."
Id. at 76. He added that, although he could not recall specific
instances, occasionally Ferriola would make suggestions based on what
he read in the newspapers, and sometimes McNeill would follow up
accordingly. Id. at 76-77.

Asked if he had ever advised Ferriola to
take cash out of his account, McNeill responded
"[s]ometimes," but then described a discussion of possible
options -- "I let him know that he had the option to do whatever
he wanted to do . . . . If you like you can take your money out at any
time." Id. at 87. The ALJ sought to follow up by asking
McNeill how many of his customers had closed their accounts with
profits.11 McNeill initially
sidestepped the question and stated that "there were clients that
took profits from the trades we made. Plenty of them." Id.
at 92. When the ALJ pressed him for verification that 20 or 50 percent
of his customers had closed their account with profits, McNeill simply
responded that he "didn't say that, no." Id. at
93.

III.

After both sides submitted post-hearing
briefs, the ALJ issued an Initial Decision dismissing Ferriola's
claims against respondent Gray but ordering respondent McNeill to pay
complainant over $50,000 in damages. Ferriola v. Transamerican
First Corp., [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH)
¶ 27,631 (May 14, 1999) ("I.D."). The ALJ did not
explicitly discuss complainant's credibility, but he found that
McNeill "was not a credible witness," id. at 47,990,
and adopted Ferriola's version of events when it conflicted with
McNeill's version of events.12
Moreover, the ALJ did not impugn Ferriola's credibility in
explaining his dismissal of the claim against Gray.13

The ALJ found that McNeill induced
complainant to open an account with Transamerican by assuring him that
he could earn "tons of money" and creating a false sense of
urgency by emphasizing the alleged seasonal nature of the unleaded gas
market. I.D. at 47,988-89. The judge ruled that McNeill's conduct
created in Ferriola's mind the false impression that a "large
return on [his] investment" was a "reasonable
expectation." Id. at 47,990. He also found that McNeill
induced complainant to submit his third $20,000 check by telling him
that "he could double his money." Id. at
47,989.14

The ALJ made limited findings relevant to
the issue of McNeill's control over the trading in
complainant's account. He noted that (1) counsel for McNeill and
Gray stipulated that McNeill recommended each trade and (2) McNeill
testified that he managed the account. I.D. at 47,989-90.

As to the excessive nature of the
trading, the ALJ noted that McNeill traded eight different option
contracts, consistently employed every dollar available for trading,
and, over a three-month period, converted nearly 70 percent of
Ferriola's $80,000 investment into commissions. I.D. at 47,990. He
also observed that McNeill traded the account when it was
"undermargined" (i.e., he began trading before
Ferriola had deposited any money) and generated a
"commission-to-ratio [sic] that far exceed[ed] 20 percent per
month." Id. Moreover, the ALJ stressed that McNeill's
explanation for why trading in OTM options was advantageous for the
customer -- the availability of increased leverage due to the lower
premium -- ignored the salient fact that the commission charge for OTM
options is precisely the same as that for ITM options. Id. at
47,989. Indeed, the ALJ concluded that:

The strategy McNeill followed was to purchase low premium deep [OTM]
options as this generated more commissions than options [ITM] or even
near the money.

I.D. at 47,990.

In light of this analysis, the ALJ concluded that McNeill violated
Section 4b of the Act and ordered him to pay complainant $50,500
($56,800 in commissions less the $6500 Transamerican paid Ferriola
plus $200 for his filing fee) and interest. I.D. at 47,990. He ruled
that complainant's release of Transamerican for $6500 precluded an
award against the company. Id.15

IV.

On appeal, respondent McNeill argues that
the ALJ should be disqualified due to his bias against the futures
industry. He also challenges the ALJ's implicit endorsement of
Ferriola's credibility and related factual assessments as
one-sided. In particular, he contends that the judge failed to give
appropriate weight to facts that reflect negatively on Ferriola's
case and argues that a balanced review of the record shows that
Ferriola failed to prove either his fraudulent inducement or churning
allegations.
DISCUSSION

I.

McNeill argues that a statement that the
ALJ made at the oral hearing demonstrates that he is biased against
the futures industry. As noted above, during his questioning of
McNeill, the judge remarked that "[t]he fix is that 95 percent
lose, the other 5 percent lose later." McNeill contends that this
remark and the ALJ's conduct during the hearing indicate that the
judge believed that a broker does not fulfill his duty to an investor
until he makes it clear that the investor will lose all of his or her
money. He claims that this amounts to a clear bias against the futures
industry that "certainly must have affected his judgment when
reviewing the facts of this case." Respondent McNeill's
Appeal Brief at 5.

The Commission has held that
disqualification of a presiding officer is appropriate when the record
establishes that the presiding officer has either (1) a personal bias
stemming from an extrajudicial source, or (2) a deep-seated favoritism
or antagonism that would make a fair judgment impossible. Kelly v.
First Investors Group of the Palm Beaches, Inc., [1994-1996
Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,753 (CFTC July 25,
1996). Because complainant does not claim that the ALJ's alleged
bias arises from an extrajudicial source, we focus on the latter
standard.

The remark McNeill cites is insufficient
to raise an inference that the judge harbors a deep-seated antagonism
that would make fair judgment impossible. The Commission has
recognized that intemperate, impatient or inappropriate remarks are
generally insufficient to warrant disqualification. Olson v.
Ulmer, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶
24,987 at 37,627 (CFTC Jan. 23, 1991) (applying the "pervasive
bias" standard). Neither the ALJ's remark or conduct go
beyond the permissible scope of behavior for a presiding
officer.

II.

McNeill also challenges the thoroughness
of the ALJ's review of the record in determining credibility and
factual issues. As noted above, the ALJ found that McNeill was not a
credible witness and adopted Ferriola's version of events when it
conflicted with McNeill's version.

The Commission generally defers to the
credibility determinations of presiding officers in the absence of
clear error. Ricci v. Commonwealth Financial Group, Inc.,
[1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,917 at
44,444 (CFTC Dec. 20, 1996). Ideally, given the general nature of
complainant's testimony and his limited explanation for falsely
claiming a $1 million net worth, the ALJ would have provided an
express credibility assessment of Ferriola. Nevertheless, we do not
view its absence as an error sufficient to warrant a de novo
consideration of credibility.16

Our independent review of the record
establishes that the weight of the evidence supports the findings
necessary to establish the elements of fraudulent inducement and
churning.17 Complainant credibly
testified that McNeill told him that he would make him (Ferriola)
"tons of money." This material misrepresentation created the
false impression that Ferriola could reasonably expect to make a large
return on his investment.18
Ferriola did sign an acknowledgment of risk, but his testimony
establishes that he only skimmed over the document because
McNeill's false representations had gotten him "psyched
up". In any case, respondents' disclosure of the risk of loss
did not cure the deceptive element of McNeill's solicitation by
informing Ferriola that the likelihood of profit was, at best, no
greater than the likelihood of loss. See Bishop v. First Investors
Group of the Palm Beaches, Inc., [1996-1998 Transfer Binder] Comm.
Fut. L. Rep. (CCH) ¶ 27,004 at 44,841 (CFTC March 26, 1997)
(providing the Commission-mandated disclosure statement is not a
general cure for deceptive conduct) ("Bishop").

The record also shows that McNeill lulled Ferriola into submitting an
additional $20,000 by telling him that he could double his money.
Ferriola's testimony that he honestly did not believe that he
could double his money raises a valid question about his reliance on
this assurance.19 The fact that
Ferriola did not take the statement literally does not establish that
he was aware of the truth. In the context of McNeill's earlier
misrepresentation, Ferriola could reasonably interpret McNeill's
statement as a reiteration of his assurance that significant profits
were likely. In these circumstances, McNeill's conduct amounted to
lulling.

Throughout this proceeding, respondents have emphasized that
complainant would have earned a profit if he had liquidated all his
positions at the right time and then ceased trading. On appeal,
McNeill raises this point in the context of mitigation. The
Commission, however, has held that the duty to mitigate damages does
not arise until complainant becomes aware of the underlying
wrongdoing. Sansom Refining Co. v. Drexel Burnham Lambert,
Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶
24,596 at 36,563-64 (CFTC Feb. 16, 1990). The record does not
establish that Ferriola learned that McNeill had deceived him about
the likelihood of profit prior to any of the times that he could have
liquidated his account at a profit. In these circumstances, McNeill
cannot establish the necessary elements of a mitigation defense.

III.

The ALJ found that McNeill controlled the
level and frequency of the trading in Ferriola's account and
traded the account to generate commissions. On appeal, respondent
argues that the record does not support either of these findings. In
addition, he criticizes the ALJ for failing to consider the nature of
Ferriola's trading objectives in assessing whether the record
establishes churning.20

To prove churning, a complainant must
show that: (1) respondent controlled the level and frequency of
trading in the account, (2) respondent chose an overall volume of
trading that was excessive in light of the complainant's trading
objectives, and (3) respondent acted with either intent to defraud or
in reckless disregard of the customer's interests. Hinch v.
Commonwealth Financial Group, Inc., [1996-1998 Transfer Binder]
Comm. Fut. L. Rep. (CCH) ¶ 27,056 at 45,020 (CFTC May 13, 1997).
Excessive trading of an options account to generate commissions
violates Section 4c(b) of the Act and

Commission Rule 33.10. Id.

Because complainant did not execute a
written power of attorney, the issue here is whether McNeill exercised
de facto control over the level and frequency of the trading in
complainant's account. In making this determination, the
Commission traditionally looks to evidence that (1) the customer lacks
sophistication, (2) the customer lacks prior commodity trading
experience and devotes a minimum of time to trading in the account,
(3) the customer reposes a high degree of trust and confidence in
respondent, (4) a large percentage of the transactions entered for the
customer's account are based upon respondent's
recommendations; (5) the customer does not approve transactions in
advance, and (6) the respondent does not supply full, truthful and
accurate information prior to obtaining customer approval for
transactions. Proof of control does not require persuasive evidence of
each factor and the weight accorded a particular factor may vary with
the particular facts and circumstances. Hinch at 45,021.

McNeill emphasizes (1) Ferriola's
admission that he knew he would be charged a commission of $160 per
trade; (2) Ferriola's admission that he knew he could accept or
reject McNeill's recommendations; and (3) evidence that the
trading in complainant's account was profitable for some time.
McNeill does not explain how the first and third factors raise an
inference that Ferriola controlled the trading in his account and we
decline to give them significant weight in our analysis.

While the second factor is germane, it is
strongly outweighed by other factors that the Commission has
identified as indicative of control. For instance, the record shows
that Ferriola was relatively unsophisticated and lacked experience
trading either securities or futures at the time he opened his
account. Ferriola credibly testified that he placed a great deal of
trust in McNeill and invariably followed his recommendations. Indeed,
respondent stipulated that all trades were based on his
recommendations. Finally, the record shows that Ferriola's
agreement to McNeill's trading recommendations was influenced by
McNeill's deception concerning the likelihood of profits. In these
circumstances the record supports a finding that McNeill controlled
the trading in Ferriola's account.

McNeill argues that the ALJ's analysis of the nature of the
trading is flawed because the judge failed to consider the aggressive
nature of Ferriola's trading objectives. The Commission's
caselaw recognizes that customer objectives are one of the touchstones
for an analysis of excessiveness. In re Murlas Commodities,
Inc., [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶
26,485 at 43,156-57 (CFTC Sept. 1, 1995). Nothing in the record
suggests that Ferriola communicated a specific trading objective to
McNeill. In these circumstances, McNeill reasonably could have
inferred that Ferriola's trading objective did not narrowly
confine the trading strategies McNeill could legitimately
pursue.

Nevertheless, the absence of a specific
trading objective does not justify the use of a trading strategy that
emphasizes the account executive's interests over those of his
customer. The Commission's analysis in Murlas recognizes
that excessive trading can take place even when a customer has an
aggressive trading objective. Murlas at 43,157. While the
Commission has traditionally relied upon several factors in assessing
evidence of excessive trading in the context of futures trading, the
parties have not developed the record on those factors in this
case.21 Commission precedent,
however, recognizes that proof of these factors is not necessarily
required in the context of options trading. Hinch, at
45,021-22.

The record shows that McNeill's
trading strategy focused almost exclusively on purchases of large
positions in OTM option contracts. McNeill favored trades in positions
that were substantially out-of-the-money, even when comparable ITM
positions were generally available. Because the premium for an OTM
option is lower than the premium for a comparable ITM option, McNeill
was able to increase the account's "leverage" by
focusing on purchases of OTM options.22

Because Transamerican calculated the
commissions it charged Ferriola based on the number of contracts
traded rather than the overall value of the position, however,
McNeill's consistent focus on large positions in OTM option
contracts also increased respondents' income from
commissions.23 It is notable that
McNeill's explanation for his focus on OTM options cited the
increased leverage inherent in his strategy but failed to acknowledge
the increased stream of commission revenue it generated.

When purchasing long option positions
customers often may achieve a comparable risk/reward posture by
purchasing fewer ITM options of the same type and total value,
rather than more OTM options of the same type and total

value.24 In these circumstances, the increased
leverage inherent in the OTM position is an illusory benefit.
Consequently, when customers are paying commissions on a per-contract
basis, an account executive seeking to serve his customer's
interests will purchase the lower-cost ITM position.

Our review of the record shows that in
several instances, McNeill could have purchased lower-cost ITM
positions with a comparable risk/reward posture than the OTM positions
he actually purchased for Ferriola's account.25 These examples raise an inference that
McNeill's focus on purchases of large positions in OTM options for
Ferriola's account was not designed to serve his customer's
interests. The record also shows that McNeill traded eight different
option contracts, consistently employed every dollar available for
trading, and, over a three-month period, converted nearly 70 percent
of Ferriola's $80,000 investment into commissions. Moreover,
McNeill's testimony that he selected trades based on current
events such as "Whitewater and Monica Lewinsky" is
impossible to square with his claims that he pursued Ferriola's
financial interests in good faith.

In light of this evidence, we conclude
that McNeill controlled the trading in complainant's account and
traded excessively in order to generate commissions. As a result, he
violated Section 4c(b) of the Act and Commission Rule 33.10.26

V.

After the ALJ issued his Initial
Decision, a dispute arose over the amount of Ferriola's damages
that remain unpaid. In awarding complainant $50,500,27 the ALJ took account of Ferriola's
receipt of $6,500 as the result of a settlement agreement with
respondent Transamerican. In addition, in July 1999, counsel for
Vision, the FCM that cleared trades for Transamerican, submitted a
letter indicating that Vision had already paid Ferriola $5,300 in
light of allegations of wrongdoing raised prior to the filing of
Ferriola's complaint.28
Counsel for Ferriola responded with a letter acknowledging receipt of
the payment, but claiming that the settlement between Ferriola and
Vision was not relevant because it was not "between parties to
this litigation."

Counsel's response is insufficient to
rebut an inference that Vision's $5,300 payment effectively
reduced complainant's out-of-pocket loss for the wrongdoing at
issue in this case. In light of the record's ambiguity, however,
we grant complainant 30 days to show cause why his damage award
against McNeill should not be reduced to $45,050 plus interest. If
complainant fails to submit a timely response, the Commission's
General Counsel, or his designee, may issue an order adopting this
Opinion and Order as a final decision awarding complainant $45,050
plus interest.

IT IS SO ORDERED.

By the Commission (Chairman RAINER, and
Commissioners HOLUM, SPEARS, NEWSOME, and ERICKSON).

1
Complainant settled with respondent Transamerican First Corp.
("Transamerican") for $6,500. He did not appeal from the
Administrative Law Judge's dismissal of his claim against
respondent Albert Gray ("Gray").

Transamerican had previously filed an
answer generally denying complainant's allegations. It later
reached an agreement with Ferriola to settle his claims for $6,500.
The ALJ dismissed the complaint as to Transamerican on the basis of
this settlement. The ALJ later vacated his dismissal and reinstated
Transamerican as a party to the proceeding as a result of a discovery
dispute raised by McNeill and Gray. In his Initial Decision, the judge
again dismissed the complaint as to Transamerican in light of the
settlement agreement.

4
As indicated above, because of the ongoing discovery dispute between
Transamerican and respondents McNeill and Gray, the ALJ treated
Transamerican as an active participant in the case despite its
settlement with Ferriola.

5
The parties' counsels stipulated that the account statements
accurately reflected the trading losses and commissions incurred.
Transcript at 37. Respondents' counsel stipulated that, with the
exception of the trade liquidating open positions when Ferriola
directed that his account be closed, all trades in complainant's
account were based on McNeill's recommendations. Id. at
29.

6
The risk acknowledgment stated that:

Customer acknowledges that investments in futures contracts are
speculative, involve a high degree of risk and are suitable only for
persons who can afford to lose all the funds invested.

Transcript at 41.

7 At an earlier point, counsel asked Ferriola
whether he believed that he could double his money in a short period
of time. Complainant responded that he "honestly didn't
believe it, but I was told I could." Id. at 45.

8 In response to questions from complainant's
counsel, McNeill acknowledged that Gray had spoken to Ferriola about
keeping his account open. He denied, however, that Gray had received a
share in the commissions generated by trading in Ferriola's
account. Id. at 111-12.

9 Out-of-the-money is a term used to describe an
option that has no intrinsic value. For example, a call at $400 on
gold trading at $390 is out-of-the-money ten dollars. In-the-money is
a term used to describe an option contract that has a positive value
if exercised. A call at $400 on gold trading at $410, for instance, is
in-the-money ten dollars. CFTC Glossary: A Layman's Guide to
the Language of the Futures Industry (1997).

10 In response to an earlier question about this
trade, McNeill noted that it was "driving season" and

Unleaded gas is a seasonal trade. If you look at the track record
sometimes it wins and sometimes it doesn't. Based on information I
had supplies being low at that particular time I thought it was going
to go up.

Transcript at 81.

11 During this questioning McNeill commented that
it was generally understood in the futures business that there was
sufficient liquidity to permit a customer to take profits "[a]ny
day." Id. at 91. The ALJ responded with the remark
"[t]he fix is that 95 percent lose, the other 5 percent lose
later." Id.

12 Illustratively, the ALJ found that McNeill
"assured" Ferriola that he could make "tons of
money." I.D. at 47,988. Similarly, the ALJ found that both
McNeill and Gray had urged Ferriola to borrow the final $20,000
deposited in his account. Id. at 47,989.

13 The ALJ essentially bypassed the question of
liability and held that there was insufficient evidence that
complainant suffered any damages due to Gray's wrongdoing. I.D. at
47,990.

14 The ALJ also ruled that McNeill's own
testimony conclusively proved that he fraudulently induced Ferriola to
open his account. He did not, however, cite to a particular aspect of
McNeill's testimony. Instead, the judge emphasized that McNeill
"virtually conceded" that most of his clients experienced
losses when they closed their accounts. I.D. at 47,990.

15 Earlier in his decision, the ALJ found,
incorrectly, that Vision had guaranteed Transamerican and stated that
Vision was "liable for any judgment rendered against
Transamerican or its agents and in favor of a customer." I.D. at
47,989. As discussed below, this finding has led to a dispute on
appeal about the proper amount of damages payable to Ferriola.

16 McNeill does not point to any error in the
ALJ's assessment of his own credibility, and our review of the
record does not suggest any defect in this aspect of the ALJ's
decision.

17 Our factual assessments diverge from those of
the ALJ in several respects. For example, as discussed below, we have
weighed the significance of Ferriola's testimony that he honestly
did not believe that he could double his money. Moreover, we conclude
that the record does not support the ALJ's findings that
McNeill's testimony (1) conceded that he managed complainant's
account, and (2) proved that he fraudulently induced Ferriola to open
and maintain his account.

19 In the circumstances of this case, however,
respondent places undue emphasis on the significance of representing
that a customer "could" double his money rather than
representing that he "would" double his money. In similar
circumstances, the Commission has recognized that a customer may be
deceived even when elements of a challenged statement are literally
true. Bishop, at 44,841.

20 McNeill's argument that Ferriola's
complaint did not raise a churning claim is frivolous. As noted above,
the complaint clearly alleges that "[t]rades generated by McNeill
and Gray were not generated to benefit Ferriola, rather they were
generated to earn commissions for [respondents]." Complaint,
¶ 23.

21 The relevant, but non-exclusive, factors that
indicate excessive futures trading include: (1) high monthly
commission to equity ratios, (2) a high percentage of day trades, (3)
the broker's departure from a previously agreed upon strategy, (4)
trading in the account while it was undermargined, and (5) in and out
trading. In re Paragon Futures Ass'n, [1990-1992 Transfer
Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,266 at 38,847 (CFTC April
1, 1992). While the ALJ purported to analyze the account's monthly
commission-to-equity ratio, he does not explain where the numbers he
cites come from and the parties did not submit any estimates of the
ratios.

22 This "leverage" rationale ignores the
fact that, all things being equal, the value of a low priced option is
less responsive to changes in the price of the underlying commodity or
other asset than is a higher priced option. For the same $10,000 the
account might purchase ten OTM option contracts @ $1,000 each rather
than two ITM options @ $5,000 each, but the sensitivity of the two
positions to changes in the underlying commodity value may be quite
similar.

23 Illustratively, if Transamerican charged a
commission of $100 per contract in the circumstances described in the
above example, Ferriola would pay a commission of $1,000 for the OTM
position and only $200 for the ITM position.

24 The value of an option is its premium, that is,
the option's market price at a given time. The premium is
dependent upon the option's strike price relative to the market
value of the option's underlying commodity or security, the
option's time to maturity, prevailing interest rates and the
volatility of the underlying instrument. An option's premium also
represents the total risk associated with its purchase -- i.e.,
the most that the purchaser can lose. Thus, two portfolios consisting
only of long option positions with the same total premium value
present equal risk, no matter how many individual options each
portfolio contains.

An option's profit potential is
measured by its delta -- that is, the sensitivity of an option's
premium to changes in the value of the underlying instrument or
commodity. Specifically, the delta shows the change in the value of
the option for a small change in the value of the instrument
underlying the option. A call (put) option's delta varies between
zero and one (zero and minus one). It approaches zero the farther the
option is out-of-the-money and approaches one (minus one) the farther
it is in-the-money. Moreover, the profit potential of a given OTM
option, as measured by its delta, is lower than that of an otherwise
identical ITM option. That is essentially why the latter is more
valuable than the former. This would appear to suggest that a
portfolio of long OTM options will not only be of comparable risk to
an equally valuable portfolio of fewer ITM options, but that it also
may have comparable profit potential. In fact, the portfolio
containing the smaller number of ITM options will always exhibit a
greater profit potential than an equally valuable portfolio containing
a larger number of sufficiently OTM options.

25 For example, on March 28, 1996, McNeill
purchased 20 July 96 unleaded gas calls with a strike price of $66 at
$.01.95 per gallon per call, for a total premium of $16,380.
Commissions (at $160 per contract) totaled $3,200. Because the July 96
unleaded gas futures price stood at $61.38 that day, the 66 call was
over $5.50 out-of the-money. If, instead of the July 96 options with a
$66 strike price, McNeill had purchased $16,380 worth of July 96 calls
at a strike price of $63. and a premium of $.02.95 per gallon per
call, only 13 contracts (16,380/(.02.95*42000)), would have been
required to obtain the same risk exposure. Ferriola would have saved
over $1,100 (7 fewer contracts @ $160 apiece) on the latter
transaction.

On the following day, March 29, 1996,
McNeill purchased 21 July 1996 soybean call options with a strike
price of $8.00 at $.16 per bushel per option for a total premium of
$16,800 and commissions of $3,360. Since the July 1996 soybean futures
price was $7.45 on that date, the purchased option was $.55 OTM. If
McNeill had used the same amount of premium to buy the ITM July 1996
soybean call with a strike price of $7.25, only about nine options
would have been purchased for a commission charge of $1,440. Ferriola
would have saved $1,920 on the latter transaction.

On April 9, 1996, McNeill purchased 20
July 1996 sugar call options with a strike price of $11.50 at a
premium per option of $.0041 per pound. Total premiums paid for this
position amounted to $9,184 and total commissions were $3,200. The
futures price on this day was $11.36. If, instead, the $9,184 had been
used to purchase July 1996 calls with a strike price of $11.00 at a
premium of $.0061 per pound per option, about 13 contracts would have
been purchased. Ferriola would have saved $1,120 on the latter
transaction.

On May 7, 1996, 30 July 1996 wheat call
options with a strike price of $6.00 were bought for $.17 and $.19 per
bushel per option for a total premium of $27,500 and total commissions
of $4,800. Since the futures price for wheat that day was $5.56, these
options were $.44 out-of-the-money. If the July 1996 wheat calls with
a strike price of $5.50 had been purchased instead, the premium would
have been $.35 per bushel per option and $27,500 could have bought 15
options. Ferriola would have saved $2,400 on the latter
transaction.

26 The complaint alleged that both McNeill`s
churning and fraudulent inducement activity violated Section 4b of the
Act. Because McNeill traded commodity options, however, Section 4c(b)
of the Act and Commission Rule 33.10 are more appropriate bases for an
award. McNeill is not prejudiced by our change in the statutory basis
for his violations, because the elements of proof for fraudulent
inducement and churning do not depend on whether the instrument at
issue is a commodity option contract rather than a commodity futures
contract. In re Staryk, [1996-1998 Transfer Binder] Comm. Fut.
L. Rep. (CCH) ¶ 27,206 at 45,810 (CFTC Dec. 18, 1997).

27 The ALJ awarded Ferriola $50,300 in damages and
$200 for the filing fee he allegedly paid. The record, however,
reflects that Ferriola only paid a $50 filing fee.

28 Counsel also noted that the ALJ had erred in
finding that Vision had guaranteed Transamerican. Commission records
also reflect that Transamerican was never guaranteed by Vision.